If the past year taught us anything, it’s to expect the unexpected. With the evolving agenda of the Trump administration—and uncertainty around political and economic policy—now is a good time to examine what, if anything, your organization should do to adjust its investments.
US and Global Economic Background
US gross domestic product (GDP) growth hit 3.5 percent in the third quarter of 2016 but fell back to 1.9 percent in the fourth quarter, according to the Bureau of Economic Analysis. It finished the calendar year with an average of just 1.6 percent.
Projections for GDP gains compare to the proverbial tortoise: slow, but steady. GDP growth could climb as high as 2.5 percent in 2017 and 2.5 percent–3 percent in 2018. Based on tightening labor markets and marginal productivity gains, these are historically low expectations.
Global manufacturing indices are the strongest since 2011, and the international economy seems to be waking up. No major economy is in a recession, and the Conference Board Leading Economic Index doesn’t suggest one is imminent.
Key Focuses of the Trump Administration
Some of the major focus areas of Trump’s administration include lower corporate and personal tax rates, pro-business regulatory reform, increased fiscal spending on infrastructure and defense, immigration, and potential trade restrictions.
Wall Street and US markets were initially optimistic about the new administration’s promise of corporate tax reform, reduced regulations, and fiscal stimulus. The administration focused on immigration and trade for the first few weeks of the new presidency, then moved on to the Affordable Care Act (ACA).
Repeal and replacement of the ACA was seen by congressional Republicans as essential before they started work on tax law changes. However, the House pulled its legislation March 24, 2017, after it became clear there weren’t enough votes for it to pass. This could be an indicator of similar difficulties to come as Congress tries to implement tax reform and stimulus spending.
Potential cuts to individual taxes are under debate. There’s concern that Trump’s proposed tax plan largely benefits top earners without much marginal benefit to be gained from increasing cash flow for this demographic. The suggested cap on itemized deductions ($100,000 for single filers and $200,000 for joint filers) could impact charitable giving. It’s unclear whether repealing the estate tax would impact bequest gifts, but a swift repeal in 2017 seems unlikely because the administration appears to be focused on other areas.
On the corporate side the benefits are clearer. Corporate tax reform has bipartisan support, and is endorsed by both consumers and businesses. Estimates on the impact of tax cuts on earnings per share from economists at various financial institutions—J.P. Morgan, Credit Suisse, and Morgan Stanley—range from an increase of 7 percent to as high as 25 percent.
There’s also talk of a tax-repatriation holiday. The last time one was offered in 2004, companies spent a good deal of cash buying back stock. Buybacks result in a lower number of outstanding shares, which has a positive effect on earnings per share—but no lasting economic benefit. The key to ensuring a repatriation holiday has a positive impact on the economy is to provide incentives for companies to put that money to work hiring and investing in capital expenditures.
The bull market in regulations since 2009 is also an easy target. Many believe that Trump’s reforms will decrease costs and expand margins, revenue, and earnings, which accelerates growth. As a result, small businesses report a greater willingness to expand spending, according to the National Federation of Independent Business—a total reversal of sentiment during the Obama administration. However, there are risks from reduced regulation, including a rise in the more destructive types of capitalism that contributed to the 2008 crisis.
Infrastructure spending could produce a temporary increase in employment, but it’s unlikely that we’ll see GDP growth much higher than the anticipated 2.5 percent with unemployment below 5 percent and tightening with little anticipated gains in productivity. If Congress implements both the tax cuts and the increased spending on infrastructure that Trump promised, we could end up with inflation and—as the Federal Reserve suggested in February—a rapid interest rate increase.
The administration’s focus on immigration is integral to any discussion of the economy and markets. Most economists agree that our economy needs immigration; we simply can’t grow based on our native-born population alone.
Another risk to growth is a trade war, a scenario that would produce no winners. Negotiations could be productive if the administration proceeds carefully.
Underlying economic fundamentals remain strong in spite of political uncertainty. Fiscal policy changes in particular will take considerable time to execute and even more time to have an effect on the economy.
We haven’t dramatically altered our outlook for 2017. Many are nervous about stocks, which are at all-time highs and seem richly valued, and bonds, which face the threat of rising interest rates. However, cash doesn’t offer any opportunity for growth or income. Many organizations will continue to focus on a diversified portfolio that adheres to their organization’s investment policy statement.
The key to maintaining target returns over the years is to take a long-term, varied approach. The current market environment presents an excellent opportunity to take gains that have produced overweights to US equity and redeploy that cash into bonds and alternative investments—assets with low correlation to both stocks and bonds. You may also want to consider individual bond portfolios, which you have much more control over, to bond mutual funds. Market timing rarely works over the long haul.
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To learn more about areas of opportunity for your portfolio or for more information on how these events and others might impact it, contact your Moss Adams wealth advisor.